Investing in the Pharmaceutical Market — A Guide to What You Need to Know

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One consequence of the COVID-19 pandemic has been that investors have suddenly shifted their attention to the pharmaceutical market. At the same time, major firms in this sector battled it out to develop and gain approval for an effective vaccine. Significant players like Pfizer (NYSE:PFE), Moderna (NASDAQ:MRNA), and Johnson & Johnson (NYSE:JNJ) have succeeded. Still, there are several other companies with their solutions in various stages of their development pipelines, each offering the potential for stock appreciation when and if these products are successful. 

How does one invest in this market? There are several ways to invest in Big Pharma, but each one depends on your appetite for risk. This industry’s hallmark is volatility, which can be driven by a number of factors. These include the number of drugs under development, the success or failure of drug trials, the impact of legislation and even external effects, as we have seen from the COVID crisis. There are, however, many ways to mitigate this risk, the best one being to buy into a fund that contains a basket of these securities and manages the risk for you.

What type of companies are included in the pharmaceutical market?

The household names in this arena tend to be very large companies. Pfizer, for example, has a market capitalization in excess of $200bn. In addition to veterinary drug and life science tools and service firms, this group also includes biotechnology companies, which may be much smaller and tend to focus on specialty niches. This type of stock may be thinly traded, but with any success or failure, you might see enormous fluctuations in a single day of trading, whether up or down.

The stock offerings for the larger firms typically trade within tighter ranges. As for our Pfizer example, since the World Health Organization declared COVID-19 a pandemic in March of 2020, PFE shares have ranged from $26 to $43, even with the development of the first successful vaccine late in the year. It trades at $35 in March of 2021, but its future potential will depend on more than just its COVID vaccine. The firm is known for its Lipitor and Viagra medications, which have patent issues, but its development pipeline is filled with exciting new possibilities. The investor is advised to assess these prospects.

Why is there so much volatility in pharmaceutical stock offerings?

Stock price volatility is often used as a measure of investment risk, and this sector’s risk tends to be independent of general market conditions. According to K.C. Ma, a finance professor at the University of West Florida in Pensacola, “The higher volatility is driven by each company’s idiosyncratic risk, research and development and the various patent and testing timetables… Mid-cap and small-cap pharma companies may also be attractive acquisition targets”.

How does one go about minimizing risk exposure when investing in drug companies? Risk diversification is the primary tool, which can be cumbersome when many stock issues are in the mix. The better method for the individual investor is to take advantage of what is called indices trading. There are several Exchange-Traded Funds (ETFs) and mutual funds that commit their respective portfolios to a basket of pharmaceutical companies, thereby enabling you to mitigate your risk by concentrating on a single indexed fund. The Top three pharmaceutical ETF funds of this type today by market size are:

  1. iShares US Pharmaceuticals ETF (ARCA:IHE)  Assets: US$359m
  2. Invesco Dynamic Pharmaceuticals ETF (ARCA:PJP)  Assets: US$330m
  3. VanEck Vectors Pharmaceutical ETF (NASDAQ:PPH)  Assets: US$233m

What factors are important when selecting individual drug stocks?

In many ways, pharmaceutical firms are no different from other stock companies. A good management team, effective cost management and a robust growth strategy for the future are necessary for share prices to appreciate. Research and development plans are also key since it can take up to 10 years and $350m to generate a new profitable product line. Pipeline and patent issues can make or break firms in this group, along with how each handles its clinical trials.

It is also important to note that 70% of all drug sales are in the United States and over 70% of all drug revenues for prominent players in this space are from patent-protected products. K.C. Ma adds, “Investors often look at the inventory of drugs with the number of remaining years of patent protection. When the patent protection for the drug expires, the owner of the branded drug will introduce a generic version in order to get a head start in the generic market”. 

Concluding remarks

Even though risks are high and the traditional R&D model in the Pharmaceutical sector is constantly evolving, this market offers exciting possibilities and the potential for above-average returns. Volatility is inherent with these stocks and suggests that a buy-and-hold approach might be best, but if you have a trader’s spirit, then market swings may be your form of opportunity.

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